GST in India and Beyond

Avalara

Goods and Services Tax, or GST, is a common transactional tax type globally. In this whitepaper, we will explore the concept of GST as it applies around the world, then delve into the specifics of how GST relates to India.

To start, let’s take a look at a roundup of the VAT/GST structure of some major world economies, including tax rates, threshold limits, exemptions, and zero-rated transactions. This provides a foundation for understanding India’s GST.

European Union (EU)

The European Economic Community (EEC) adopted VAT throughout Europe, replacing cascading multi-stage turnover tax. VAT was implemented due to the ease with which it handled cross-border transactions and facilitated the development of a common market.

The VAT Directive sets the framework for VAT structure in the EU, but leaves national governments with the freedom to set the number and level of rates they choose. They may use provisions of VAT Directives in national legislation, subject to the following basic rules:

  1. Goods or services supplied in the course of business by a taxable person within the EU are subject to VAT at a standard rate not lower than 15%, unless specifically exempt.
  2. EU member states can opt to apply one or two reduced rates of not less than 5%.
  3. Member states may subject certain goods or services listed in Annex III of the VAT Directive, such as food, water, pharmaceuticals, books, admission to cultural/amusement/sporting events, social services, medical services and equipment, agricultural inputs, to lower rates, including zero rates, which were in place on Jan. 1, 1991, though they cannot introduce any new rate under 5%.
  4. Goods and services in the public interest, such as medical care, services linked to welfare and social security work by public entities or charitable organizations, certain education and cultural services, specific financial and insurance services, certain supplies of land and buildings, export of goods, and shipments of intra-EU supplies are exempt from VAT.

Canada

In Canada, GST is applicable on supply of most goods and services, including real property and intangible personal property, and is governed by the Excise Tax Act. Canada has a federal government (like India’s), and a federal GST was introduced in 1991 to replace the existing federal sales tax imposed on manufacturers and certain licensed wholesalers at a general rate of 13.5%. However, all provinces continued with the provincial retail sales tax (‘PST’), thereby having two levels of tax levied. The harmonized sales tax (HST) is imposed in provinces that have harmonized their provincial sales tax with the GST (New Brunswick, Nova Scotia, Newfoundland and Labrador, Ontario, Prince Edward Island) and is a combination of a federal component and a provincial component (5-8%) applicable generally on the same base of property and services as the GST.

In the remaining provinces, GST is imposed on taxable goods and services, along with provincial sales tax or a retail sales tax.

The three territories (Northwest Territories, Nunavut, and Yukon), as well as the province of Alberta, charge GST at the rate of 5%. Most goods and services supplied in or imported into Canada are considered taxable supplies, and are subject to GST at the rate of 5% or HST in the range of 13% to 15% (federal component of 5% and provincial component of 8 to 10%), with certain exceptions based on policy decisions, such as:

  • Exports and supplies of goods and services relating to basic needs of individuals, such as drugs and biologicals, medical and assistive devices, basic groceries, agriculture and fishing, transportation and travel etc. are taxed at the rate of 0% (zero-rated).
  • Supplies of goods and services supporting public needs such as certain real property, healthcare, educational, child and personal care, legal aid, public sector bodies, financial services, ferry/road/bridge tolls etc. are exempted from GST/HST.

New Zealand

The New Zealand GST, enacted in 1988, was designed as a comprehensive tax base including many difficult-to-tax goods and services. The New Zealand GST became an international benchmark for indirect tax design. For instance, the Institute of Fiscal Studies of United Kingdom considered the New Zealand GST model as the benchmark for evaluation of European VAT Directives.

In New Zealand, GST is governed by the GST Act of1985 and is applicable on most indigenous goods and services, most imported goods, and certain specified imported services at a rate of 15%.

The “Goods” category includes all types of personal and real property except actionable claims, money, and products transmitted by a non-resident to a resident by means of wire, cable, radio or other technical systems. The “Services” category covers everything other than goods or money.

When supplying certain goods and services, such as exported goods and services or telecommunication services, the supplier is governed by a territorial authority. Proceeds from the local authorities, sales of going concern (slump sale), and sale of land are subject to GST at the rate of 0%.

Supply of certain goods and services, such as private property (car or home not used for business), financial services such as interest payment on loan or bank fees, donated products and services sold by nonprofit organizations, rentals of residential property, and penalty interest are all exempt from GST.

Australia

The implementation of New Tax System package in Australia, including New Tax System (Goods and Services Tax) Act of 1999, was considered a landmark change to the Australian tax system. The new GST replaced the federal wholesale sales tax and some state and territory taxes with a single tax rate of 10% on the supply of most goods and services, with some exceptions.

  • The basic rule of GST in Australia is destination-based consumption tax, with limited tax base exclusions.
  • Certain supplies, such as certain food products, most medical and health services, drugs, medical aids and appliances, most education courses, childcare, exports, religious services, and international transport are known as GST-free (other counties refer to these as zero-rated).
  • Certain supplies, such as financial supplies, residential rent, residential premises, precious metals, school shops and canteens and fundraising events conducted by charities are known as input-taxed supplies (other countries refer to these as exempt) and no GST is applicable on such supplies.

Observations from VAT/GST in Other Jurisdictions

A trend can be observed from the VAT/GST legislation and provisions in the aforementioned jurisdictions. VAT/GST are destination-based, and therefore apply to consumption taking place in the respective country/region. These taxes, therefore, exempt exports and tax imports.

Furthermore, input tax credits can be claimed for the cost of procuring and producing, in the case of zero-rated supplies, and cannot be claimed in case of exempted supplies.

VAT/GST has emerged as the successful choice among other forms of indirect taxation. Jurisdictions using these taxes work continuously toward reforming structural issues. An example of this occurred in December 2010,  when the European Commission published a Green Paper on the future of VAT, arguing that there were “numerous shortcomings in the current VAT system which create obstacles to the Internal Market, cause burdens for businesses and prevent Member States from benefiting from the true potential of this tax.” The paper also pointed out the system is susceptible to fraud.

Businesses report finding the EU VAT model very complicated, due to its complicated exemption application rules. Reduced rates among member states cause competitive distortion and create additional compliance costs borne by businesses conducting cross-border trade when compared to businesses that only trade domestically. In Canada, businesses face challenges under GST/HST due to interpretation issues and the variation of tax rates between provinces. Although British Columbia harmonized its PST with the GST in July 2010, it re-implemented PST in 2013. In all jurisdictions, even New Zealand and Australia, compliance costs under VAT/GST have been reported to burden small businesses more.

Proposed GST Structure in India

The proposed GST in India consists of a consumption-type VAT, in which only final consumption is treated as the final use of a good. GST is expected to integrate taxes on goods and services across the supply chain, allowing for offsets and capture of value addition at each stage. A continuous chain of offsets is expected to be established, from the level of the original producer or service provider to the retailer’s level, which would eliminate the burden of all cascading (or “tax on a tax”) effects. Suppliers at each stage would be permitted to set off the GST paid on the purchase of input goods and services against their GST obligations to be paid on the supply of goods and services.

Salient features of the proposed GST model based on reports of the Empowered Committee are summarized below:

  1. Aligned with the federal structure of the Indian government, the proposed GST model consists of a dual structure (like in Canada) to be levied and collected by the Union government [referred to as Central GST (CGST)] and respective State governments [referred to as State GST (SGST)]. This dual GST model would be implemented and governed by one CGST/IGST statute applicable across the country, SGST statutes for each state, and common rules determining valuation, place of supply, and place of origin.

This would imply that the Centre and the states would have concurrent jurisdiction for the entire value chain and the basic principles of law, such as chargeability, definition of taxable event and taxable person, and measure of levy (including valuation provisions and basis of classification) will be uniform across State statutes. Draft laws are already written and under internal discussions. Also, various allied rules are in the process of being drafted and finalized.

  1. CGST and SGST would be comprehensively applicable to all goods and services up to the final consumer (retail) level, reflecting the tax base of a typical consumption VAT. Therefore, CGST and SGST would be applicable to all transactions involving supply of goods and services made for a consideration, except alcoholic liquor for human consumption, exempted goods and services, goods which are outside the purview of GST, and transactions below the prescribed threshold limits.
  2. Based on recommendations of both the 13th Finance Commission and Empowered Committee, GST on following products shall be levied from a date to be notified by the GST Council –
  • Petroleum Crude
  • High Speed Diesel
  • Motor Spirit (commonly known as Petrol)
  • Natural Gas
  • Aviation Turbine Fuel
  1. GST is to be structured on the destination principle, so that the tax base shifts from production to consumption. This way,  imports will create a tax liability while exports will be relieved of the burden of GST. Consequently, revenues will accrue to the State in which the consumption takes place or is deemed to take place.
  2. Taxes paid on input goods/services against CGST shall be allowed to be utilized as input tax credit (ITC) against output tax liabilities under CGST, and the same principle applies to SGST. Cross-utilization of input tax credits between the Central GST and the State GST would not be allowed, except in case of interstate supply of goods and services. Therefore, a taxpayer or exporter shall be required to maintain separate details in books of account for using or refunding credit.
  3. In order to maintain an uninterrupted credit chain, CST would be phased out in case of interstate transactions of taxable goods. On such transactions, Centre would levy Integrated GST (referred to as IGST, which can be calculated by adding CGST to SGST) with appropriate provision for consignment or stock transfer of goods and services. The inter-state seller will pay IGST on value addition after adjusting available credit for IGST, CGST, and SGST on his purchases.
  4. The importing dealer will claim credit of IGST while discharging his output tax liability in his own state. The relevant information will also be submitted to the Central Agency, which will act as a clearing house mechanism, verify the claims, and inform the respective governments to transfer the funds.
  5. A uniform threshold across all states and Union territories is being considered, with adequate compensation for the states (particularly, the states in the North-Eastern Region and Special Category States) where a lower threshold had prevailed in the VAT regime.
  6. In view of the fact that the CGST and SGST are intended to be levied on consumption of all goods and services, these two taxes must subsume all taxes presently levied on various goods and services by the Centre and the states, respectively. With an objective of free flow of tax credit in intrastate and interstate levels, following indirect taxes are proposed to be subsumed:

Central Levies – Central Excise Duty, Service Tax, Excise Duty levied under the Medicinal and Toilet Preparations (Excise Duties) Act of 1955, Additional Duty and Special Additional Duty of Customs, Central cesses and surcharges insofar as they relate to supply of goods and services.

State Levies –  Value Added Tax/Sales Tax, Entertainment Tax (other than the tax levied by the local bodies), Central Sales Tax, Octroi and Entry Tax, Purchase Tax, Luxury Tax, Taxes on lottery, betting and gambling, State cesses and surcharges insofar as they relate to the supply of goods and services.

Expectations from proposed GST Regime

The global spread of VAT/GST reinforces the success of the VAT/GST system of indirect taxation over any other form of tax. With India inching towards a GST regime, a set of key expectations surrounds economic development, growth in international trade, moderate taxes, and stability in prices. Taxpayers hope for the new tax structure to be simple and uniform, clear and transparent, making compliance easier through administrative improvements and the creation of simpler and faster mechanisms for redressing grievances.

Economic Expectations

The existing indirect tax system of multiple levies across sectors of production has led to reports of distortions in the allocation of resources, as well as production inefficiencies. Non-recoverable taxes built into retail costs make Indian products more expense than their imported equivalents, making it difficult for domestic producers to compete. GST is therefore expected to provide a boost to exports by mitigating costs. This change is estimated to increase exports by 3.2-6.3%.

The broad objectives behind introducing a comprehensive GST in India include harmonization and consolidation of multiple indirect taxes in India, the creation of a common national market by widening the tax base and cutting down exemptions, mitigation of cascading and double taxation, and promotion of voluntary compliance through a lower overall tax burden on businesses and end consumers. Today, the GST design includes aberrations, like a 1% additional tax, exclusion of certain sectors of the economy, and exclusion of certain taxes that make the design deviate from these objectives. It is expected that these aberrations would be temporary, and the GST will eventually be an all-encompassing tax that can fulfill the expectations of Indian businesses and people. It is hoped that with GST encouraging compliance, economic sectors that currently constitute parallel economies would enter the mainstream and further boost the GDP.

Taxpayer Expectations

As per OECD guidelines, the generally accepted principles of tax policy applicable to consumption taxes are applicable to domestic as well as international trade. These principles include neutrality, efficiency, certainty, simplicity, effectiveness, and fairness. The proposed GST structure in India is expected to use best practices established by current VAT/GST countries. Taxpayer expectations include the following:

  1. Tax Neutral:

Tax neutrality ensures that tax ultimately collected on a particular supply chain is proportionate to the amount of tax paid by the final consumer. A credit mechanism to prevent breakages in credit chain is anticipated under the GST regime in India. With moderate rates, this mechanism will be tax neutral, does not lead to any increase in prices of goods and services, and serves the interests of producers catering to domestic and international markets without undue advantage to one over another.

  1. Simple, efficient and uniform:

GST is expected to overcome the issues and shortcomings of the existing indirect tax structure. Historically, the indirect tax regime in India has been very complex, with multiple levies at multiple taxable events. GST is expected to introduce a simple, efficient, and uniform indirect tax structure in India with a comprehensive tax that may be levied on the supply of all goods and services, using the same tax base. Expectations are that a taxable event would occur simultaneously on supply of goods and services, and taxability would not be dependent on ‘goods’ or ‘services’ (as it is under the current regime). Additionally, existing complexities relating to works contracts, software, and intellectual property are expected to be eliminated, making taxation of such transactions simpler and reducing the overall tax burden. Challenges being faced at present by sectors such as ecommerce, telecom, financial services, real estate, and so on, are expected to be addressed and resolved. The complexities of the existing system concerning valuations and classification of goods and services, on account of the varied interpretations and rulings, will be eliminated. There is also expected to be a lower administrative burden due to the increased simplicity of standardizing GST returns/challans and payments, as well as providing for easy access through a central web portal for registration and refunds.

  1. Clarity in GST legislations:

Benefits of a comprehensive national GST are greatest with common laws and rules applicable across states and Centre. Since the now-released (as of June 30, 2016) Model Draft of GST Act is available in the public domain, it still remains unclear which rate structure and redressal mechanism will be adopted. Clearly-drafted legislation will go a long way toward making GST a success.

Closing Comments

Because GST has been shown to be a simple, efficient, and successful form of indirect taxation globally, its introduction by target date (April 1, 2017) would contribute significantly towards economic growth. The GST is keenly awaited by all who have lived through the maze of the current inefficient, irrational and complex indirect tax system in India.

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